Business Interruption Litigation
Before the Bench
Test cases and consolidation requests emerged as business interruption complaints, driven by COVID-19, flowed into the courts this summer.
- Kate Smith
- September 2020
- Busy Summer: July saw two notable litigation maneuvers—the U.K. test case and the U.S. hearing to consolidate federal business interruption lawsuits into a single case.
- Merging Cases: With more than 400 federal cases filed in the U.S., plaintiffs asked the courts to merge cases to create efficiency, a move the insurance industry opposed.
- Providing Clarity: In hopes of bringing certainty to the market, the Financial Conduct Authority asked the U.K. High Court to interpret common policy language.
Lydia Savill hopped on the same webcast throughout the last two weeks of July. Whenever she had a chance, the senior associate at London law firm Hogan Lovells tuned in to watch a live stream of the U.K. High Court's virtual hearing on business interruption insurance.
She wasn't alone. The Financial Conduct Authority's “test case” against insurers captured the market's attention this summer, with at least one news outlet blogging a play-by-play of each side's legal arguments.
“There were a lot of people in the market who were paying close attention,” Savill said.
Typically a slow month for insurance news, July was filled with legal drama this year as business interruption lawsuits stemming from the COVID-19 pandemic took center stage on the insurance litigation landscape.
What the FCA has done is pick a number of policies that represent the trickiest issues and the most common wordings on these points.
As new cases of COVID-19 began rising at alarming rates earlier this year, governments around the world shut down businesses to prevent the spread of disease. Within weeks of the March lockdowns in the U.S. and Europe, insurance executives and experts began to predict a tsunami of business interruption lawsuits related to the closures.
The first wave has formed.
Across the U.S., businesses have been filing lawsuits en masse against insurers over denial of business interruption claims related to the global pandemic. As of July 31, there were 973 COVID-19-related insurance lawsuits filed in the U.S., according to law firm Hunton Andrews Kurth, which tracks litigation.
With more than 400 business interruption-related lawsuits filed in U.S. federal court, plaintiffs' attorneys asked a Judicial Panel on Multidistrict Litigation to consolidate cases in an effort to expedite them.
That hearing was held on July 30, the same day the FCA wrapped up its eight-day test case.
As claims denials rolled in in the U.K. during the spring, the FCA took a proactive approach, announcing in May that it would ask the High Court of Justice Queen's Bench Division to interpret a sampling of policy language under the legal system's test case mechanism. The intention, the FCA said in announcing its plan, was to “resolve the contractual uncertainty around the validity of many BI claims.”
The Insurance Council of Australia (ICA) and the Australian Financial Complaints Authority (AFCA) have undertaken a similar effort. In late July, they agreed to file a test case that would consider the application of infectious diseases cover in business interruption policies.
“The landscape is changing almost daily,” said Kymberly Kochis, partner at Eversheds Sutherland and co-head of its insurance litigation and class action defense group. “In order to be on top of everything, it's a full-time job.”
These rulings are the beginning of the legal road rather than the end, experts said, as appeals are likely.
“Our view has been that we expect those exclusions to hold but, because of those lawsuits already in progress and more to come, that this will play out over years, not over months,” Stefan Holzberger, chief rating officer at AM Best, said. “So the defense and containment costs could be very significant for these companies, even if they get a favorable verdict.”
I think the industry is cautiously optimistic based on the early court cases and ruling around the contract language. Judges have come back and confirmed that the existence of COVID-19 does not constitute a direct physical loss or damage to a covered property.
Business interruption litigation was a recurring theme in second-quarter earnings calls. Chubb CEO Evan Greenberg said the insurance industry is “under attack” from trial bar attorneys looking to “reverse engineer” policy language to force business interruption insurance coverage.
Indeed, plaintiffs' attorneys have pursued multiple angles and arguments, including asking the courts to invalidate the standard Insurance Services Office virus exclusion and bar insurers from enforcing it (Crossroads Investments, LLC v. Philadelphia Indemnity Insurance Co.).
“I put that into the category of creative arguments,” Kochis said of the attempt to void the virus exclusion. “I'm not sure how successful that will ultimately be.”
Still, she said, it shows that plaintiffs' attorneys will try every avenue. And all eyes are on these early cases to see which arguments stick and how the courts lean.
“Both sides are watching the early decisions closely,” Kochis said. “Plaintiffs' lawyers and plaintiffs themselves are watching the early decisions to see which direction courts are headed and whether there's any creativity in terms of the plaintiffs' arguments and the courts' decisions.”
Some U.S. insurers' property policies include business interruption or business income as a coverage within the policy, while others, including those insurers that use Insurance Services Office (ISO) forms for their policies' content, add this coverage with an endorsement.
Before the virus exclusion even comes into play, a policyholder must have suffered direct physical loss or damage to property. While plaintiffs have argued that the coronavirus and the ensuing lockdowns met that threshold, two notable early decisions have gone in favor of insurers.
In the case Social Life Magazine Inc. v. Sentinel Insurance Co. Ltd., a New York publisher said the coronavirus caused damage to its Manhattan office, thus preventing it from printing its luxury lifestyle magazine. U.S. District Court Judge Valerie E. Caproni, in the Southern District of New York, ruled against Social Life, saying the virus “damages lungs. It doesn't damage printing presses.”
In early July, Judge Joyce Draganchuk of Michigan's 30th Circuit Court reiterated that the coronavirus harms people rather than property. In Gavrilides Management Company et al. v. Michigan Insurance Co., a restaurant group argued that government shutdown orders created a physical loss of property. Draganchuk rejected the argument, stating that a tangible alteration to a property is required to trigger coverage.
“There has to be something that physically alters the integrity of the property,” Draganchuk said.
The two cases have been seen as good signs for insurers.
“I think the industry is cautiously optimistic based on the early court cases and ruling around the contract language,” Holzberger said. “Judges have come back and confirmed that the existence of COVID-19 does not constitute a direct physical loss or damage to a covered property, and reinforced the argument that businesses are closed because of the fear of the guests or shoppers spreading the virus, which is different than if you were to have some sort of chemical spill or gas leak in the place of business.”
Debate over these issues is likely to surface in just about every business interruption insurance lawsuit. To prevent duplicating the costs and effort spent answering common questions, multiple plaintiffs' groups asked the Judicial Panel on Multidistrict Litigation to merge federal court suits into a Multidistrict Litigation (MDL).
More than 400 people dialed in to listen to the livestreamed MDL hearing, in which attorney W. Mark Lanier, who represented several plaintiffs, argued that all policies have common issues of fact.
“This is an issue not only to the United States economy but [of] how we thrive in an unprecedented worldwide catastrophe in really uncharted territory,” Lanier said. “There are few cases that have this much riding on it.
“There are a number of common issues of fact, regardless of state, insurance company or policy,” he added “This boils down to five words in contract language: direct physical loss or damage.”
Lawyers for the insurance industry disputed the simplification of language.
“It doesn't matter that all the policies require property damage. What property damage means is a legal issue,” the insurance industry's lead counsel, Richard Goetz of O'Melveny & Myers, told the seven-judge panel.
Goetz argued that consolidating hundreds, if not thousands, of lawsuits into a single case would be a “nightmare” and would create inefficiency rather than alleviate it.
The court agreed. It rejected the motion for industrywide consolidation on Aug. 12, stating that “an industrywide MDL in this instance will not promote a quick resolution of these matters.”
“Put simply, the MDL that movants request entails very few common questions of fact, which are outweighed by the substantial convenience and efficiency challenges posed by managing a litigation involving the entire insurance industry,” the court added.
However, the panel did leave the door open for single-insurer MDLs, indicating consolidation could be appropriate for cases against the four carriers facing the bulk of the litigation—Cincinnati Insurance Co., certain underwriters at Lloyd's, Hartford Financial and Society Insurance.
Attorneys for the four carriers were ordered to appear before the panel on Sept. 24 to explain why the pending litigation should not be merged.
Kochis said early decisions could set the tone for additional lawsuits in the U.S.
“If plaintiffs start to win, then you have incentive for other plaintiffs to file,” Kochis said. “So you could see additional suits in that scenario. But even if they win right now in these preliminary stages, there will be an appeal, probably no matter who wins. It's going to take a while to get a ruling that's definitive.”
UK Test Case
The U.K. debate is markedly different. Coverage under standard business interruption policies is not in question. Policyholders have not challenged virus exclusions and have not contended that the virus caused physical damage to property.
The battle is over a less common type of policy: non-damage business interruption policies. Such policies extend business interruption coverage without requiring policyholders to prove their property suffered physical damage. They also specifically include coverage for “notifiable diseases” and shutdowns imposed by authorities due to a danger or emergency within a specified radius of the premises.
“In these cases, whether BI resulting from government actions to control a pandemic such as COVID-19 should be covered would very much be dependent on the contract wording,” Catherine Thomas, senior director, analytics, at AM Best's London office, said. “What has become evident is that policy wording across the market is inconsistent. In some instances, whether the coverage applies or not in a pandemic situation, where you have a BI loss due to government actions to control that pandemic, is not clear.
“There can be a real disparity between what the insurer believes is covered and what the insured believes is covered.”
To resolve uncertainty around claims, the FCA asked insurers to participate in a test case. Arch Insurance (UK) Ltd., Argenta Syndicate Management Ltd., Ecclesiastical Insurance Office plc, Hiscox Insurance Co. Ltd., MS Amlin Underwriting Ltd., QBE UK Ltd., Royal &Sun Alliance Insurance plc and Zurich Insurance plc agreed to join the test case as defendants.
The regulator combed through those insurers' non-damage business interruption policies and selected widely used phrases to present to the High Court for interpretation.
“What the FCA has done is pick a number of policies that represent the trickiest issues and the most common wordings on these points,” Savill said.
The FCA also asked all insurers, including those not named in the test case, to examine their policies for wordings similar to those under consideration in the test case. While only defendants will be bound by the test case ruling, Savill said the expectation is that all insurers will adhere to the outcome.
The test case specifically looked at denial of access clauses and notifiable diseases clauses.
Broadly speaking, denial of access clauses are triggered when a “competent authority denies or hinders access to an insured premises due to an emergency or danger within a certain specified vicinity of the premises,” Savill said.
Insurers have argued this threshold was not met.
“They're saying that even if a policyholder can show that there were cases of COVID in the relevant five miles, 25 miles or whatever vicinity was specified, that wasn't the reason the premises were closed,” Savill said. “The premises were closed because the government said it was imposing the lockdown because of the national situation.
“The FCA's case on causation included the argument that a national danger encompassed a local danger. Just because the lockdown was imposed on a national basis doesn't mean there wasn't a danger or occurrence of COVID in any individual location in the U.K. And it was precisely for that reason that there was a national lockdown, because the danger was everywhere.”
Authorities added COVID-19 to the list of “notifiable diseases” in March. Notifiable disease clauses are triggered by the presence of a notifiable disease on the premises.
“There is no debate that COVID was made a notifiable disease,” Savill said. “The question is whether the premises were closed because of an occurrence of a notifiable disease at or within the relevant vicinity of the premises.
“What happened here is, premises weren't closed by the government specifically because they had COVID on their premises; rather they were closed as a protective measure to stop the spread of the disease, as part of the lockdown.”
The High Court was expected to rule within a relatively short time frame. The decision likely will be appealed either way. Thomas said the test case was generally viewed positively by all sides.
“It really is to speed up that process so you don't have to have individual policyholders taking individual insurers to court,” she said. “When the outcome does come, it should provide policyholders with greater clarity as to whether they'll receive payment from insurers or not. Otherwise that could be a lengthy and costly process because of legal fees.
“Just the fact that they get some certainty and don't incur legal costs is a positive for the policyholders. Meanwhile, the insurers will have a better understanding of which policies are expected to respond to these COVID-19 related business interruption claims, and they'll be able to pay out and reserve accordingly. The certainty that they get from that is, again, a positive. And they'll also presumably save on legal costs as well.”
Following in the footsteps of the U.K., Australia also has scheduled a test case. In Australia, however, exclusions are the primary issue.
The Biosecurity Act of 2015 replaced the Quarantine Act of 1908, yet some business interruption policies still reference the Quarantine Act. Policyholder attorneys argue that exclusions referencing the Quarantine Act should not hold up.
To find resolution on the matter, the ICA, which represents the general insurance industry, and the AFCA, which serves as an ombudsman in financial disputes, have asked the Federal Court of Australia to decide whether references to a quarantinable disease under the Quarantine Act should be construed as a reference to a listed human disease under the Biosecurity Act.
The outcome of the test case will be used by the AFCA to determine relevant complaints arising from business interruption claims.
“A decision from a superior court will assist insurers, AFCA and customers in developing a better understanding of how exclusions in policy documents respond to the unique circumstances of the COVID-19 pandemic,” Rob Whelan, CEO, Insurance Council of Australia, said in a statement.
“Insurers believe the intention of pandemic and communicable human disease exclusions are clear. However, a judicial determination will provide insureds and AFCA with greater legal certainty on this issue.”
Kate Smith is managing editor of Best’s Review. She can be reached at email@example.com. Frank Klimko contributed to this story.